What is a Private Issuer? Why is it Important?

All corporations are governed by securities legislation that generally requires “prospectus level disclosure” for the issuance of shares.  This level of disclosure is expensive for any corporation and often prohibitively expensive for private corporations.  As a result, many corporations issue shares under National Instrument 45-106 – Prospectus and Registration Exemptions (“NI 45-106”), which sets out a variety of exemptions from the prospectus level disclosure otherwise required under securities legislation.  One of the primary exemptions used in this regard, particularly for start-up corporations seeking initial financing, is the “private issuer” exemption.  New corporations should attempt to fit into, and stay within, the requirements of this exemption as long as possible.

To fit into the private issuer exemption, a corporation must:

1. not be a reporting issuer or an investment fund;
2. be a corporation whose securities, other than non-convertible debt securities, are subject to restrictions on transfer that are contained in the corporation’s constating documents or shareholders agreements;
3. have securities, other than non-convertible debt securities, that are beneficially owned, directly or indirectly, by not more not more than fifty (50) persons, not including employees and former employees of the corporation; and
4. have distributed securities only to persons who fit within prescribed categories.

Most law firms ensure that the required share transfer restrictions are included in the corporation’s Articles of Incorporation.  However, the required restrictions can also be added later through Articles of Amendment.  The 50-shareholder restriction is self-explanatory.  However, it is important to note that securities can only be distributed to persons included in prescribed categories.  If the corporation’s security holders don’t fit into a prescribed category, the exemption is lost.  The prescribed categories include:

1. a director, officer, employee, founder or control person of the corporation;

2. a spouse, parent, grandparent, brother, sister or child of a director, executive officer, founder or control person of the corporation;

3. a parent, grandparent, brother, sister or child of the spouse of a director, executive officer, founder or control person of the issuer;

4. a close personal friend or close business associate of a director, executive officer, founder or control person of the issuer;

5. a spouse, parent, grandparent, brother, sister or child of the selling security holder or the selling security holder’s spouse;

6. a security holder of the corporation;

7. an accredited investor (as defined elsewhere in NI 45-106).

This is not a complete list, but it’s close.  As a rule of thumb, eligible shareholders under this exemption are people whose investing experience, or whose relationship to a director, executive officer, founder or control person of a corporation, enables them to assess and rely on the corporation’s collective capabilities, trustworthiness and business acumen when investing in the corporation.

The private issuer exemption is one of the key ways by which start-up companies can raise capital in the early stages of the business plan.  Sooner or later, many corporations outgrow the restrictions described above and lose the exemption, but it’s better to do it later rather than sooner.  Your lawyer can help you with that.

This article was originally published in the October 10, 2009 edition of the Ottawa Business Journal.